The financial markets largely continued their upward path in the first three months of 2015, though the gains were very uneven. While U. S. equities posted more moderate returns than the past two years, other developed markets surged. Europe was led sharply higher by European Central Bank President Mario Draghi’s unveiling of a massive QE (quantitative easing) policy, while Japan was helped by the strength of the dollar.
Emerging markets, with the exceptions of India and China, lagged for the most part. Global bond yields fell, with 10-year Treasuries down again to 1.92% while comparable German and Japanese sovereigns kept creeping toward the zero mark. Oil, last year’s surprise, continued lower with other commodities, while U. S. dollar strength and its effect on domestic growth and inflation were noted by the Federal Reserve.
A number of factors besides the strong dollar have led economists to lower their expectations for first quarter growth: the West Coast dock slowdown, poor weather throughout most of the country, and layoffs and spending cuts in the oil patch. Indeed, earnings growth for stocks is now projected to be down slightly for the first two or three quarters of 2015, with energy being the major culprit. Nevertheless, warmer weather is slowly returning, the dock slowdown is over with backlogs decreasing, and consumers have more money to spend as a result of significantly lower gasoline prices. If oil remains well under 2014 levels, we anticipate many companies may begin to raise earnings forecasts in the next few months due to energy savings.
“The latest pronouncements from Fed voting members indicate a more dovish tone, with Fed Futures markets now anticipating the first rate increase in September or even December, rather than June.”
When the Federal Reserve will begin to raise short term borrowing rates, — remains a critical unknown. The latest pronouncements from Fed voting members indicate a more dovish tone, with Fed Futures markets now anticipating the first rate increase in September or even December, rather than June. There also appears to be a shift lower in the normalized Fed Funds rate, or the eventual end point of tightening, by the majority of Fed officials. For the rest of 2015, economic reports will be analyzed even more carefully than usual for further clues about the timing of interest rate increases.
So far in 2015, the local economy in Hawaii has benefited from lower oil prices, and the unemployment rate is down to approximately 4%, which should translate into higher wages soon. Tourist arrivals are up, but visitor spending has lagged for some time now. Real estate is also mixed, with residential doing well while commercial, especially the office market, continues under some pressure.
We remain constructive in our outlook for U. S. and developed market equities. In 2014, we switched our foreign equities to become currency hedged (neutral), as the stronger dollar detracted from returns. We anticipate the greenback to remain strong, though it should not increase at as fast a pace as it has over the past year. Treasury bond yields will likely be range bound, with the prospect of eventual Fed tightening offset to some extent by ultralow Eurozone and Japanese rates.
Emerging markets remain very mixed. While Russia and Brazil are slipping into recessions, the Chinese market is surprising to the upside, in spite of slowing economic growth. While further gains are possible, we are concerned by the parabolic rise and excessive use of margin debt in China.